Long-term liabilities (also called non-current liabilities) are financial obligations of a company that are due after a year or more. Long-term liabilities are presented on a balance sheet of a company together with current liabilities which represent payments due within one year.
Classification of liabilities into current and non-current is important because it helps users of the financial statements in assessing the financial strength of a business in both short-term and long-term. While information about current liabilities of a company (together with its current assets) provide vital information about liquidity of a company, long-term liabilities (together with non-current assets) are critical for assessment of its long-term solvency.
IAS 1 Presentation of Financial Statements provides a more technical definition of long-term liabilities. It defines non-current liabilities as liabilities other than current liabilities. Current liabilities are defined as liabilities that are expected to be settled within normal operating cycle, held for the purpose of trading, expected to be settled within 12 months OR for which the company does not have any unconditional right to defer payment.
Long-term liabilities = liabilities - current liabilities
Following is a list of some typical long-term liabilities:
- Bonds payable
- Loans payable
- Deferred tax liability
- Pensions payable
- Post-retirement healthcare obligation
- Finance lease payable
Not all bonds payable or bank loans payable are long-term in nature. Bond and loan repayments that are due within a year are classified as current liabilities and the rest are reported as long-term.
Companies raise money either (a) through issue of shares, which represent ownership stake in the company or (b) through issue of debt instruments, which represent a fixed amount to be repaid (together with interest) over a specified period of time in future. Bonds payable represent the later scenario i.e. financial obligations of a company which have a specified return and repayment date.
While bonds payable represent financial obligations towards general investors (both individual and institutional), loans represent amount obtained typically from a bank or another company (such as sister concern or associate). Loans carry either a fixed or variable interest rate which the borrowing company pays over the term of the loan. The principal amount of the loan is either repaid at the end of the loan term or over the term of the loan.
Deferred tax liability
Deferred tax liability represents income tax payment a company saved today but which it shall be required to pay in future due to difference between financial accounting recognition criteria and tax laws.
Pension payable liability arises when a company has a defined benefit plan. It is the present value of the amount the company shall pay the employees in future as compensation for their employment to date.
Post-retirement healthcare obligation is a liability similar to pensions payable in that it represents the expense the company is expected to incur in future to provide healthcare facilities to its employees after their retirement as compensation for their employment so far.
Leases payable represent the present value of the lease payments a company shall make in future in return for use of an asset. Lease payable is recognized only where a lease is classified as finance lease.
Ratios involving long-term liabilities
Following ratios have a long-term liabilities component:
- Debt ratio
- Equity multiplier (i.e. financial leverage ratio)
- Return on capital employed
- Debt coverage ratio
Long-term Liabilities vs Current Liabilities: Company A has the following liabilities as at 31 December 2014:
- Lease payable of $10 million (of which $1 million is payable each quarter).
- Net pension liability of $20 million (of which $2 million is payable by 31 December 2015).
- Bonds payable of $30 million (of which $10 million are due for payment on 30 June 2015). Interest accrued on the bonds as at 31 December 2014: $1 million.
- Bank loan of $10 million which originally due in 2017, but the company has defaulted on a covenant which has entitled the bank to demand repayment right now.
Find the amount that should be classified as non-current on the company's balance sheet as at 31 December 2011.
Long-term lease payable amounts to $6 million ($10 million minus $4 million paid over the next year i.e. $1 million in each quarter).
Long-term net pension liability is $18 million ($20 million minus $2 million).
Bonds payable of $20 million ($30 million minus $10 million on 30 June 2015). The whole amount of interest payable is current in nature because it is due immediately.
Though bank loan was originally a long-term liability, the default on a covenant has rendered it current because the company no longer has unconditional right to defer payment. Hence, the bank loan amount of $10 million is a current liability.
Total long-term liabilities that should appear on Company's A balance sheet as at 31 December 2015 amount to $47 million ($6 million plus $18 million plus $20 million).
Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork